Pastor, Tithing Sway Church Loan Risks

Come Sunday, pews across America fill with parishioners seeking a spiritual uplift as pastors share sermons to help congregations make it through another week.

But for budding preachers with dreams of overseeing their own flocks, they have to first get past the strict scrutiny of lenders who are likely leery of originating loans for properties that some experts see as the most risky type of commercial real estate to be involved in.

Yes, commercial real estate. For however churches see themselves, most credit unions and other lenders still view them as businesses. And they are susceptible to the ebbs and flows of the economy.

More than 500 Chapter 11 bankruptcy petitions were filed by faith-based institutions between 2006 and 2011, according to research from University of Illinois law professor Pamela Foohey. Since 2010, 270 churches have been sold after defaulting on their loans and in 2011. Of those, 138 churches were sold by banks, Reuters reported last year.

Credit unions have not been immune to the financial troubles of churches particularly during the last few years of the Great Recession. Dozens of them continue to grapple with foreclosures on both small churches and large, multimillion dollar mega churches.

Because of their strong reliance on pledges, capital campaigns and other factors, some credit unions and CUSOs keep church loans to a minimum.

“A church is considered a specialized single-purpose building, which is a high risk when it comes to resale and a recapture of principal,” said Kent Moon, president of Member Business Lending LLC in West Jordan, Utah.

Church loans tend to require a higher down payment, and lenders most likely will provide less financing, Moon added. On other properties, financing can go up to 80%, but with churches, the funding might potentially drop to 65%.

Member Business Lending has reviewed more than 100 churches with underwriting, Moon said. However, because of their risky nature, the CUSO doesn’t keep the loans on its system. One commonality that brings sustainability is having a school attached to the church to generate additional revenue.

“We encourage our client base to not have any concentration of these types of properties,” Moon explained. “One of the downsides of a recession is in commercial lending. On a single-purpose property such as a church, getting a sale is very limited.”

For some, the type of church may be a factor when it comes to financing.

Next Page: Small Churches More Risky

“Every church lending opportunity should be evaluated on its own merits, but we strongly recommend to our credit unions they avoid small churches with less than 200 members or independent churches,” said Mike Gudely, president/CEO of Innovative Business Solutions, a Fort Mill, S.C.-based business lending CUSO.

The reason being is that evangelical independent churches don’t have the financial and administrative backing the mainstream denominations do, Gudely said, adding if something happens to an independent church, they have to go it alone.

“If an independent church has problems it’s easier for members of the denomination to go elsewhere because they don’t have a history with the church,” Gudely offered. “In many mainstream denominations, people were raised in that denomination, have a family history, and generally stay in the same church, no matter if financial issues or leadership issues come about.”

Innovative Business Solutions has six church loans totaling $2.5 million, Gudely said. While the CUSO bids on several each year, the transactions often never get off the ground. The mainstream denomination loans are very competitive when the banks get involved, he noticed. With the low rates, it’s hard to put a participation loan together, especially when the CUSO adds in the servicing fee, Gudely noted. When it comes to underwriting, IBS relies on church loan research in RMA Journal articles, which provides a good consistent benchmark, he pointed out.

The viability of cash flow is a critical factor when it comes to church loans because they are hyper sensitive to economic cycles, Moon said. A higher amount of patronage during good times will produce a strong debt coverage ratio, which is the inverse of the loan to value or how many times you’ve covered your loan principal by the liquidation of your collateral. For instance, if it’s a $100,000 loan and the liquidation is $120,000, the debt coverage ratio would be 1.2%.

Another element that makes church loans risky is their impact when a recession hits, Moon said. When cash flow dries up, a credit union will likely have a high percentage of troubled debt restructured loans. In May 2012, the NCUA Board approved a final rule indicating TDRs will be calculated consistently with loan contract terms, rather than requiring past due status to be reported until six consecutive on-time payments have been made, among other provisions.

“You have to have enough performing assets to cover a high level of TDRs. A high concentration of church loans in the portfolio will create a high number of TDRs and if you talk to any credit union, they’ll tell you a church loan is a long term TDR,” Moon said.

There are roughly seven church loans totaling more than $2 million in the portfolio at Community Business Lenders in Des Moines, Iowa, said Mark Kilian, president of the CUSO. They’re local, small in size and nowhere near some of the funding provided to mega churches similar to the troubled Without Walls International Church in Lakeland, Fla. The CUSO has not had any defaults on its church loans most likely because a list of factors is scrutinized before funding is even considered.

“The type of church becomes an issue based on historic giving, the pastor or pastors, and why attendance has gone from X to Y,” Kilian said. “Doing business locally helps us understand the environment and marketplace. Even though it’s a church, it’s still a business.”

During the recent recession, the churches that were provided loans through CBL’s credit union clients continued to make their payments because they were able to generate enough cash through attached entities such as schools or other centers, Kilian said.

In fact, CBL is currently reviewing a project from a church that has a daycare center, a larger congregation in a growing suburb and a successful capital campaign. Another church is looking to expand to a bigger facility but Kilian cautioned there are some conditions under consideration since a larger property means higher operating costs.

“It has to go back to the historical financials of the church and evaluating capital campaigns. Are they three or five years and are there certain givers that represent the total pledge or are there 20 families who contribute to bulk of the pledge,” Kilian said. “All of those factors need to be evaluated.”

Indeed, tithing at many churches takes a hit during a recession, Moon said. However, the quality of cash flow can be determined by the quality of the pastor, he offered. If he or she has a strong following and is young and vibrant, it’s more likely cash flow can remain consistent.

“The average recession lasts about 36 months. If I’m financing a church for 30 years, I’m going to probably go through five or six recessions,” Moon said.